Commercial opportunities in rented property management – the story from South Cambridgeshire

In 2013 South Cambridgeshire District Council launched Ermine Street, a housing management company, with £7m of loan funding for buying housing to place in the private rented market. In November the council approved a further £100m expansion of the business. Alex Colyer, South Cambridgeshire’s chief financial officer, explains the thinking behind Ermine Street’s model and growth plan.

Room151: How did Ermine Street come about?Alex Colyer (AC): The drivers were looking for a commercial opportunity, like every local authority in the country, as a way of meeting the grant reductions coming our way. We’ll be down to zero grant next year and that was a trajectory we were certain was going to happen and has been confirmed.

So, really, we were looking for a way of filling the gap without cutting services.

Commercial activity was top of our list. But we don’t want to be competing in the local government space.

The other dynamic is a recognition that we’re living in an overheated housing market in this part of the country.

There are commercial landlords out there but we recognise that there is space for more. It’s a segment that’s not well served, from a volume point of view.

We thought it was a way of leveraging our housing management skills to both support the economy, provide good quality rental opportunities and make some money out of it as well.

Room151: What was the basic model for Ermine Street?AC: The model is we acquire housing units, from surplus investment cash, and do that through a company vehicle using our trading powers – that’s an important point to make – and primarily aiming ourselves at private sector rents, certainly not trying to avoid the HRA restrictions coming through.

Its very much about commercial rent levels. The core model is lending our trading arm the cash [£7m in the pilot phase] to acquire housing units, at a commercial rate. And that’s better than the opportunity cost of lending to a bank.

There’s a virtue and necessity in that. The necessity is state aid. Because it is a company we have to lend at a commercial rate of interest. The virtue is that there is a return to the council on that basis.

Room151:What did you see as the risks confronting you?AC: The two risks are [firstly] that government changes the rules – the rules around trading, the general powers of competence and trading powers that exist within that.

To a degree we’ve seen that happen in terms of social housing stock. We’ve had a major change in the environment there, with being required to reduce rent, which has a serious impact on hour business plan. We’ve gone from having a major house building programme down to a trickle.

And now, obviously having to fund right to buy for housing association tenants by forced sale of our council stock. So, government was, and is, top of our [risk] list.

The other risk is about the housing market and that changing. But we think that’s a small risk. A collapse in house prices is likely to see more people going into rental anyway. If house prices and rent yields go up we’ve got some exit routes there as well.

There’s a bit of interest rate risk. With such a high proportion of debt supporting the company, if interest rates rise the rent yields don’t cover the operations of the company. If the interest rate environment changed dramatically the company’s break even point goes further out into the future.

Room151:Ermine Street is now expanding with £100m investment over the next five years. How has that come about?AC: We used the pilot phase to explore how the model works best. We probably tried about nine different models, we tried a number of activities. We’ve established which bits work and which have less value and moved the business forward.

The core bit that works is a straight forward rental. What we’ve been able to do is look at different tenure types, rather than just plain vanilla rentals. We can offer different sorts of tenancies that the market can’t offer.

The premise ramping it up is about making sure we exploit the economies of scale. Like any start up you have fixed costs and being able to absorb those over a bigger trading base, and more properties, spreads the risk better. And the overall cash return becomes more meaningful.

Room151: Where does the £100m come from? Investment surpluses?AC: Some will be yes. But if we are successful, as we think we will be, we will look to borrow some of that as well. There will be some debt and we’ll use opportunities for getting a better return on our investment pool as well.

Room151: Do the risks remain the same?
AC: To a degree they are mitigated. If there is a wholesale collapse in the housing market that becomes more pronounced and we’ll have to be careful.

The advantage is that we won’t need to liquidate the stock right away. A wholesale housing collapse, we think, would be accompanied by a move by people into the rental sector. The strategy is that we would seek to hold out and consolidate in the rental sector. What it means is that we wouldn’t have the immediate exit strategy.

With the other risks we can mitigate by saying we’ll sell the company or selling the units within the company. Certainly, in the housing market in this part of the country, that’s not too much of a challenge.

The other side of the risk is opportunities. Thus far we’ve been acquiring units. The opportunity for us is to commission and build units. That’s the opportunity we weren’t able to explore in the pilot.

A separate commercial arm we’ve set up with our partners in the City and the county council can both build houses for us and provide those services to others. Ermine Street will be a customer of that housing development as well.

Ermine Street property, South Cambridge

Room151: Ermine will become a substantial business, will there be a temptation to sell it?AC: It’s there as any option. The key driver is producing a revenue for the council in the context of diversifying our revenue streams. But we recognise that there may well come a point – a different environment for local authorities – and there may be an opportunity to sell.

We know that there are a number of lenders who would like to acquire a packaged housing management company, but don’t want to set it up themselves. That’s our key exit strategy. We know a housing company like this [Ermine Street], with a decent amount of stock and tenancies, would be attractive to the market.

The other thing to bear in mind is that although £100m is a lot of money, I don’t wish to say it isn’t, we are still only looking at something in the region of 450-500 units. As a landlord it’s a decent quantity, but it’s not a huge amount of stock.

Room151: Why this particular kind of model?AC: There’s lots of different local circumstances. I’m really conscious that there are certain places where local authorities are holding surplus land which they’ve been looking … to develop and the market is not bringing those sites forward for them. So they are setting up housing companies to do that.

There are other projects to provide more affordable rental stock. Ermine Street isn’t about that. Our activity is purely a commercial activity. We think we can offer something distinct in the local market place.

For example, because of the nature of the housing market in Cambridgeshire there are a number people, both at university and at local employers, post-grads, who come on a three-year contract. They can’t afford to buy and they’re only here for three years.

We think we can offer something to meet that need that the normal buy-to-let landlord can’t offer just because their funding covenants are so different. They’d be offering six months, plus a month notice as a standard. If you’re here for three years, you don’t want to move after six months.

It’s an example of where we can do things differently. We’re very conscious that there are good landlords out there and we want Ermine Street to be amongst the best. We want to be the best private sector landlord we can be.

Room151: Has Ermine Street produced a return for the council?
AC: The company’s made a return back to the council in the year that’s just finished of over £200,000. We’re estimating that over the next two years the return will increase to £600,000.

Alex Colyer (L) and the Ermine Street team

Room151: What have you learned along the way?AC: For us its about making sure the culture and the empowerment within the organisation works for the team, recognising that we have the skills (we always knew that) – but ensuring the softer environment around those skills works.

We learned to embrace risk and manage risk. And to exploit innovation and ideas that colleagues have, as well as empowering colleagues to take those ideas forward. Being honest when things don’t work. Exploiting it when they do.

It’s about sharing a colleague’s vision, understanding and taking it forward, perhaps in ways we hadn’t thought of. That sounds grand, but it’s about making sure the organisation is agile and flexible enough to exploit the opportunities when they come.

A traditional local authority decision making tree doesn’t work for that. You spot an opportunity today and if you need to go through the whole process a traditional local authority would require, it doesn’t work, the opportunity might have gone and somebody else might have taken it

Room151: You need to get in more of a private sector frame of mind?AC: Absolutely, which is why I was making the point about the softer skills and the softer side of the management. Don’t get me wrong, this is a very performance management driven activity, but it needs to be agile and fleet of foot.

Room151: What advice would you pass on?AC: One of the things we did right from the start was put a lot of effort into understanding our local housing market. We did detailed research down to a granular level to understand how our local market works.

If I was passing anything on to colleagues elsewhere it would be: you need to exploit what works in your area. If the pressure is about development activity, focus on that, if it’s about gaps in the housing market, focus on that. Every single housing market is different. The drivers for what works and doesn’t work will be different in all areas.

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